Caterpillar Earnings Preview: Falling Crude Oil Prices And Weak Mining And Construction Activity Will Have Negative Impact

Caterpillar (NYSE:CAT) will release its Q3 2015 earnings results on October 22nd. We expect the company’s sales to down year to year due to continued weakness in the world economy and foreign currency headwinds. The impact of weak global economic growth was visible through the 13% decrease in sales observed in the second quarter of 2015, with sales volume declining by nearly 10%. We believe this weakness is likely to continue and don’t expect material impact of cost reductions and restructuring efforts implemented so far. The future could be different though. Considering the current economic conditions and mature stage of the industry, improving operational efficiency is going to be the key factor governing Caterpillar’s profits.  The company has expanded its cost reduction and restructuring efforts, and announced in September that it expects to lower the operating costs by $1.5 billion annually, expanding the operating income margin by ~1.5% – 2.0%. ^[1]  The company’s stock has under-performed compared to the broad market index S&P 500 this year so far. The stock has plunged from $92 on January 2, 2015 to current level of $69 (down 24.6%), while the S&P 500 is down 1.49% in the same period. ^[2] This can be attributed to prolonged weakness in its major markets such as Latin America and Asia/Pacific  (primarily China).

See our complete analysis of CAT here

Weakening Oil Prices And Mining Activity

Falling oil prices posed a challenge to Caterpillar’s operations in the second quarter and we expect the trend to continue through 2015. In August, crude oil prices fell to a six year low due to oversupply. ^[3]  With falling prices, globally production is being downsized and the rig count has fallen by around 62% since last October. The rig count is an indicator of future production. Additionally, U.S. crude output fell by 6.7% in September. Falling crude oil production led to a 22% decline in Caterpillar’s Asia/Pacific sales on account of lower end user demand for construction and mining equipment and products used in oil and gas applications. Similarly, their sales slumped in North America and remained flat in other regions. Future price projections do not reflect positivity either with Moody’s lowering its price assumption for Brent Crude oil in 2016 from $57 per barrel to $53. ^[4] We continue to expect a negative impact of oil price on the company’s total sales.

Caterpillar has witnessed a decline in global mining activity since 2012. In May 2015, mining production fell 0.3%, registering its fifth consecutive monthly decline. ^[5] With low commodity prices, mining customers have remained focused on improving productivity in existing mines leading to low mining equipment sales or new orders. The worst hit regions in the segment were EMEA, North America and Asia/Pacific. We expect the downward trend in commodity prices to continue and the outlook for mining activity remains weak.

Weak Construction Activity In China And Brazil

Caterpillar’s sales from the construction industries segment have suffered due to lower end user demand for construction equipment and products. In Q2 2015, the worst hit regions in this segment were Latin America (down 47%) and Asia/Pacific (down 30%). The slowdown in the Chinese economy drove the weakness in residential construction activity. Similarly, in Brazil, economic turmoil has produced weakness in construction activity, which has been amplified by the absence of  large government orders in Brazil that continued into the second quarter.  This has pulled down construction sales in the region. We expect continued weakness in the segment in the short term driven by continued slowdown in China’s economic growth, partially offset by the absence of quarter over quarter impact of the Brazilian government order in the next earnings.

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1. Caterpillar Announces Restructuring And Cost Reduction Plans, Caterpillar, September 24, 2015 [↩]
2. Caterpillar Stock Price Movement, NYSE, October 20, 2015 [↩]
3. US Oil Prices, The Wall Street Journal, October 9, 2015 [↩]
4. Moody’s Lowers Oil Price Assumptions, Moody’s, October 19, 2015 [↩]
5. US Industrial Output Hurt, The Wall Street Journal, June 15 2015 [↩]